Stay Away From Enterprise Tech Stocks

by Tom Taulli | July 9, 2013 1:23 pm

Stay Away From Enterprise Tech Stocks

Even though the Dow is up almost 17% this year, a few groups — including enterprise tech operators — have been notable laggards. Just take a look the dismal performance of some of the biggest names in the industry, along with some new kids on the block.

Company

Ticker

YTD Return

Oracle

ORCL

-5.7%

IBM

IBM

-0.1%

Qualcomm

QCOM

-3.8%

SAP

SAP

-10.2%

VMWare

VMW

-30.4%

Salesforce.com

CRM

-8.5%

Red Hat

RHT

-9.5%

AVERAGE

—

-9.7%

What gives? To start, global issues have been weighing on the stocks. While the U.S. economy is improving, the growth rate remains muted. Besides, the mega-operators have already reached saturation in the states so, to find growth, they must look to emerging markets.

Unfortunately, there are headwinds here too. According to the International Monetary Fund, the main driver is the tapering of the Federal Reserve’s bond purchases. Basically, investors are taking capital out of emerging markets and putting it into high-yielding securities in the U.S. As a result, the IMF has reduced its forecast for this year and next year.

In fact, today Goldman Sachs analyst Bill Shope downgraded shares of IBM (IBM[1]) because of the slowdown. Granted, the weakness in emerging markets could be temporary. If anything, there should ultimately be a return to stronger growth and this will likely mean a nice uptick in IT spending.

But that’s not the only headwind. Many governments have also engaged in aggressive fiscal policies in the face of recent fiscal crises. Austerity — especially in the U.S. and Europe — is not good news for large tech enterprise operators, which generally have the scale to sell to governments.

And unfortunately, the austerity trend also is likely to last a while.

The issue that could be the most dangerous for the mega-operators industry disruption, though. Over the past decade, a variety of new trends in the enterprise industry have put pressure on big-time enterprise tech operators. Perhaps the most notable is cloud computing — technology that centralizes applications in datacenters. Cloud technology lets customers invest less in servers, middleware and databases, and has meant slackening demand for information technology consultants.

It’s not just the technology, but the business model of cloud computing that has been disruptive, though. The model is based on subscriptions — not traditional, large upfront licenses and ongoing maintenance fees. With companies looking to cutback on costs, it should be no surprise that they prefer subscriptions.

Oracle (ORCL[2]), IBM and SAP (SAP[3]) have ramped up their M&A to add cloud computing assets, but the deals have not been cheap … and are really a process of trading a more profitable business in for one with lower margins.

Plus, there are other new technologies that could pose problems. For example, so-called NoSQL databases are becoming more popular since they do a better job of handling Big Data and mobile and are much cheaper than offerings from IBM, Oracle and SAP.

Considering the headwinds and subsequent stock struggles, investors may wonder if there is a valuation play on the sector. Unfortunately, valuations are still far from cheap, as seen with the chart below. A P/E of 13 or more assumes that there will be decent growth.

Company

Ticker

p/e ratio

Oracle

ORCL

13

IBM

IBM

13

Qualcomm

QCOM

17

SAP

SAP

23

VMWare

VMW

39

Salesforce.com

CRM

N/A

Red Hat

RHT

61

Considering industry disruption and deceleration, such growth doesn’t seem likely and it’s probably best to stay away from these stocks for now.

Tom Taulli runs the InvestorPlace blog IPO Playbook[4]. He is also the author of High-Profit IPO Strategies[5], All About Commodities[6] and All About Short Selling[7]. Follow him on Twitter at @ttaulli[8]. As of this writing, he did not hold a position in any of the aforementioned securities.